UK Equity Income funds are some of the most popular with our clients. Partly due to the low level of return currently available on other traditional sources of income, such as bank deposits or government bonds. Most funds in this sector aim to generate a rising income, as well as increase the value of your original investment over the long term. Any income can be paid out to you as cash or reinvested back into the fund to help boost long-term growth.
Different fund managers take different approaches to income investing. Some focus on larger companies that are seen to be more stable and have paid regular dividends for many years. Others invest in higher-risk small and medium-sized companies. These might pay a lower income to start with but can have more dividend growth potential. Increasingly some managers also use their ability to invest up to 20% of the fund overseas to add diversification and allow exposure to sectors and industries less available in the UK equity market.
Investing in a dividend-paying company can mean your income and capital grows as the company grows. The best companies will grow their profits and dividends over the long term, though not all companies' profits – and therefore their dividends – are sustainable. The extraordinary events of 2020 provided a particularly harsh lesson in this regard as the effects of the Covid-19 pandemic severely impacted upon many companies' ability or willingness to pay dividends.
In general, however, we like equity income funds as an expert fund manager invests in a range of companies reducing the impact if one gets into trouble. It's less risky and more convenient than trying to choose individual shares yourself.
Interest rates are at historic lows. And despite some inflationary pressures they're unlikely to rise significantly in the short term. This makes the prospect of regular and growing dividends from some of the UK's most successful companies attractive.
Dividends are clearly important for investors who require income, but an equity income fund can also be relevant for those seeking capital growth. If not required now, dividends can be reinvested to increase the number of shares held, from which more dividends can be taken at a later date. Repeating this process over a long period (known as compounding) is a way to grow capital, though there are no guarantees.
We think equity income funds can provide an important element of almost any investment portfolio. Keeping cash aside for a rainy day is important and an income fund could be considered for savings that aren't needed in the medium term. Reinvesting dividends when you don't need the income could potentially help your pot grow at a faster rate. However, investments and their income don't offer the same security as cash, and will go up and down in value, so you could get back less than you invest.
Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.
2021 has seen the prospect of some return to normality. Global markets reacted positively to the announcement of an effective antibody for the Covid-19 virus.
Over the past 12 months to the end of June 2021 the IA UK Equity Income sector returned 25.5%*, while the FTSE All Share returned 21.5%, the FTSE 350 Lower Yield index (made up of UK growth companies) returned 18.1% and the FTSE 350 Higher Yield index (mainly value-focused companies) returned 23.2%. Income funds tend to invest more in value companies with higher dividends, which contributed to stronger returns for UK Equity Income funds. UK smaller companies did especially well compared to larger companies, though the UK more broadly still lagged global markets.
Until later in 2020 and the vaccine announcement, value investing was out of favour. We've since seen a reversal and companies whose prospects are more closely linked to the health of the economy (cyclical sectors) and reopenings have recovered, such as travel & leisure and oil. Sectors that previously held up better, such as Food & Drug retailers, lagged. Initially in 2021, this trend continued however a mix of sectors have done well recently such as technology, healthcare, industrials and utilities.
Many UK Equity Income funds have the potential to hold up better in adverse market conditions. But in early 2020 the speed and scale of the Covid-19 crisis had an immediate impact on dividends. Some of the natural hunting grounds for income, such as banks and oil, were hit hard as the pandemic reduced demand for travel and damaged economic growth.
Dividends across the UK market fell by 41.6% over the year to the end of March 2021 according to Link Group. Banks, miners and oils were hit most. Larger companies were typically more resilient than smaller ones. Some companies have since grown their dividends such as food retailers. However, Link believes it may take until 2025 for the overall levels of dividends to recover to pre-pandemic highs.
Dividends have long been a key element of the UK market and we expect this to continue. Some industries, such as oil, have reduced dividends to more sustainable levels which we feel is a sensible longer-term strategy.
We think the UK Equity Income sector can be an excellent way to grow your wealth over the long term. There is some evidence UK companies look better value than other global markets after many years of being in the doldrums. Companies paying higher dividends have generally done better than lower-yielding ones over the very long term, but there are no guarantees this will continue. Volatility is likely to persist in the near term, especially while the world continues to battle the pandemic.
In the past 10 years the IA UK Equity Income sector returned 94.8%* compared with the FTSE All-Share's 85.5% gain. Remember past performance isn't a guide to future returns.
Chart showing 10 year performance of the UK Equity Income sector vs FTSE All-Share
Past performance is not a guide to the future. Source: *Lipper IM to 30/06/2021.
Each of the funds below can take their charges from capital. This can increase the yield but reduce the potential for capital growth. All investments can fall as well as rise in value so you could get back less than you invest. There is a tiered charge to hold funds with HL. It is a maximum of 0.45% a year - view our charges.
Our Wealth Shortlist features a number of funds from this sector, selected by our analysts for their long-term performance potential. The Shortlist is designed to help investors build and maintain diversified portfolios. To use the Shortlist, you should be comfortable deciding if a fund fits your investment goals and attitude to risk. For investors who don't feel comfortable building and maintaining their own portfolio we offer ready-made solutions, which are aligned to broad investment objectives. For those who want personal recommendations, you can also ask us for financial advice.
Wealth Shortlist fund reviews
The fund's managers are disciplined in seeking out companies they think can grow their cash flow, as that's what ultimately pays investors' dividends. They also keep the fund diversified, to reduce the impact of any dividend cuts on the wider portfolio. Adrian Frost, Nick Shenton and Andy Marsh mainly invest in large UK companies, but they also invest in medium-sized and overseas companies if they think there's an excellent opportunity. Frost is one of the most experienced managers in the UK Equity Income sector, and we think he's built a talented team around him.
The fund has outperformed the FTSE All Share over the past year, even though it received less in dividends than in the previous year. Overall, the managers are pleased with how their holdings have performed through the pandemic.
They focus on both growing companies and overlooked ones that offer good value. William Hill, 3i Group, Aviva and Anglo American performed well, though Tesco and London Stock Exchange were weaker.
We think the managers' combined skill, discipline and experience puts them in a strong position to deliver healthy income and long-term growth, but there are no guarantees. The managers have the flexibility to invest into high yield bonds which if carried out can increase overall risk in the portfolio.
The fund managers look for companies which are market leaders with a competitive advantage and predictable cash flow. This tends to be a concentrated fund, so each holding can have a significant impact on performance, both positively and negatively, and can therefore increase risk. Chris Murphy is an experienced income investor and has managed the fund since April 2009. He was joined by co-manager James Balfour in June 2016.
The managers target a higher income than the FTSE All Share, alongside capital growth over the long term. The core of the portfolio is invested in high-quality, cash-generative companies, but they also look at companies that are recovering or unloved by other investors. In addition, they invest in some higher-risk medium-sized and smaller companies.
They currently invest more in financials, such as Intermediate Capital, and industrials, such as Melrose, than the benchmark. They have recently been less keen on some of the popular income sectors such as healthcare and consumer defensives.
The fund outperformed the FTSE All Share over the past year, although this is no guide to future returns.
Jupiter Income focuses on undervalued UK companies which could pay a dividend, so the fund can add diversification to an income portfolio. This style bias can mean the fund is out of favour through certain periods of the market cycle.
Ben Whitmore has managed funds for more than 20 years and is experienced when it comes to unearthing undervalued companies. He is assisted by Dermot Murphy. As well as the Jupiter Income fund, the two run Jupiter UK Special Situations and Jupiter Global Value Equity, using the same process and value bias. Whitmore invests in some overseas companies in this fund too, providing some diversification.
Whitmore and team have been steadfast in their value style through thick and thin. This has taken them into more economically sensitive parts of the market such as BP and Kingfisher. They have avoided more highly valued and defensive sectors such as consumer sectors. This discipline and patience has been rewarded over the past year with returns ahead of both the benchmark and peers.
We think the fund would work well alongside other UK equity income funds with a different style bias to add diversification. Investors should be aware that this is a concentrated portfolio which can increase the volatility of returns.
Siddarth Chand-Lall focuses on income opportunities among small and medium-sized companies, which have more growth potential than bigger ones though they are higher-risk. Investments in smaller companies, including AIM listed companies, makes this fund different to many others in the UK Equity Income sector. Small and medium-sized UK companies outperformed the broader UK stock market and UK Equity income peers over the past 12 months, and so has the fund.
The fund is focused on areas such as financials and real estate, which can be good income providers. Polar Capital, Intermediate Capital and Big Yellow all contributed to the fund's outperformance. Holdings in more defensive companies such as GlaxoSmithKline and Telecom Plus were weaker over the year.
We rate Chand-Lall highly and think he has the support of one of the UK's strongest smaller company investment teams. Most UK Equity Income funds gravitate towards the largest companies on the stock market, so this fund could be a good diversifier to an income-focused portfolio.
The fund blends high-quality dependable dividend-paying companies with some unloved companies the manager thinks have the potential to recover and boost the fund's gains. The fund is quite concentrated so if one holding gets into trouble it can have an adverse effect on performance.
Richard Colwell's an experienced manager who, unlike many others in the equity income sector, only invests in UK companies. He's bold and patient enough to invest in unloved and unfashionable companies he thinks have good long-term potential. The fund has performed better than the FTSE All Share over the past year, but that is no guarantee of future performance.
The manager favours companies and industries that aren't as closely tied to the success of the economy, so the fund invests less in energy, mining and banks. Over the last year investments in RSA Insurance and Electrocomponents have done well. RSA Insurance was sold after the announcement of its takeover and the profits were used to invest in another insurer Direct Line. Holdings in Imperial Brands and GlaxoSmithKline detracted.
We like Colwell's sensible approach, doing the simple things well, and think this fund could provide a good foundation for an income portfolio.
The fund has a slightly different objective to other income funds. It aims to provide a rising income, but with lower volatility than the market and an emphasis on sheltering wealth in a falling market. This is a trait of Troy's range of funds and makes the fund a good diversifier compared to others in the sector.
The fund is managed by a team of three, based around the experienced Francis Brooke who has managed this fund since launch. Additional resource was added recently to the team, with an eye to longer-term succession planning. The team works closely with other members of Troy who share a common investment philosophy.
A key element of the approach is to avoid economically sensitive, less consistent businesses and those that require high levels of investment to keep going. There is a greater focus on larger companies compared to some other income funds. The managers also invest up to 20% overseas where they find the best opportunities not available within the UK market. This is quite a concentrated fund and, while the team focuses on minimising losses, it could be susceptible if one or more of their holdings gets into trouble.
They like high-quality, dependable companies that could do well even when the economy is weak, such as Diageo and Compass Group. Overseas companies such as Paychex and Medtronic offer diversification to industries less common in the UK. The fund has underperformed peers and the FTSE All Share over the past 12 months, although it has still grown.
The fund held up relatively well in the early chaotic weeks of the pandemic as dependable and cash generative companies were considered a safe port in the storm. However, when investors became euphoric on the announcement of effective vaccines these types of companies were discarded in favour of those more sensitive to improving economic conditions. Holdings in Next and St James's Place performed well as beneficiaries of online commerce and rising savings levels. The steadier Reckitt Benckiser and Nestle detracted.
This fund invests in Hargreaves Lansdown plc.
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Please note the research updates are not personal recommendations to trade. If you are unsure of the suitability of an investment for your circumstances please seek advice. Remember all investments can fall as well as rise in value so investors could get back less than they invest.
Our expert research team provide regular updates on a wide range of funds.